What Bernanke Couldn't Quite Say

Federal Reserve Chairman Ben Bernanke used his much-anticipated Friday speech at the Fed's annual end-of-summer conference in Jackson Hole, Wyo., to sound almost like the last Keynesian. As he put it: "Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces."

Commentators made much of the fact that Bernanke said that he considered the economy dangerously soft; that unemployment was far too high for this stage of a recovery; that housing continued to be a major drag, as well as state and local budget cuts. Fed chairmen are famously Delphic. But Bernanke was blunt:

Growth in recent quarters has been tepid, and so, not surprisingly, we have seen no net improvement in the unemployment rate since January. Unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time.

Bernanke reviewed the Fed's non-traditional interventions that have kept interest rates at historic lows -- the massive purchases of government and other securities; the efforts to lock in very low interest rates for longer-term bonds; and vowed that "Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery."

Despite his caveats, the financial press generally interpreted Bernanke's words as meaning that the Fed would undertake even more heroic measures to drive interest rates even lower. Perhaps the Fed will, but that was not the import of Bernanke's remarks at all. His point was that the rest of the government had to do some heavy lifting, too.

"It is critical that fiscal policymakers put in place a credible plan that sets the federal budget on a sustainable trajectory in the medium and longer runs. However, policymakers should take care to avoid a sharp near-term fiscal contraction that could endanger the recovery."

Translation: we will never get a strong recovery just by relying on cheap interest rates. We need a more sensible fiscal policy.

A Federal Reserve chairman is not supposed to address such topics, because taxing and spending are not part of his franchise. But to the extent that the failure to stimulate the economy has put unrealistic pressure on the Fed to work miracles, fiscal policy is necessarily the Fed's business.

What Bernanke hinted at, but couldn't quite say, was this:

While we need to bring deficits down over the long term, for the next few years we need more stimulus, not less. It isn't just a matter of avoiding "the fiscal cliff," as Bernanke warned. We need far more government spending.

The closest Bernanke could come to saying this was by expressing polite concern about fiscal "headwinds." As he put it: "Notwithstanding some recent improvement in tax revenues, state and local governments still face tight budget situations and continue to cut real spending and employment."

Translation: government should not be cutting back in a deep recession; it should be making up for the shortfall in private purchasing power.

In the 1930s, when the United States faced a far deeper depression, we built the Golden Gate Bridge, the San Francisco-Oakland Bay Bridge, the George Washington Bridge and the first modern highway systems; we constructed and renovated thousands of public schools, fire stations and post offices; planted a billion trees; laid 20,000 miles of water mains; electrified rural America and undertook countless other public works projects. And when the early projects were not sufficient to end the Great Depression, we doubled down.

This time around, President Obama in February 2009 persuaded Congress to enact a $787 billion stimulus program that his own advisers considered inadequate, but one that did a lot of good -- for two years. Then nearly all of the stimulus spending petered out. Of the total, the Congressional Budget Office estimated that $718 billion was spent by 2011. And by 2011, of course, Republicans controlled the House so no further stimulus was politically possible.

Today, there is so much public infrastructure in disarray, such a crying need to move the nation to a sustainable energy path, and so great a need for the jobs that could be created by large-scale public investments that more stimulus spending should be a no-brainer. But this alternative is not even being seriously debated. Rather, Democratic paths to deficit reduction are jousting with Republican paths.

So here is Ben Bernanke -- a Republican, first appointed by George W. Bush, a huge admirer of Milton Friedman -- saying what no other Republican and too few Democrats are willing to say: The problem is not the deficit, but the risk that Congress will overreact to the deficit.

The problem is not that some undeserving soul might get too much mortgage relief, but that government housing policies are too feeble and the undertow of a collapsed housing sector is sinking the recovery. And even with 4 percent mortgages, brought to you courtesy of the Fed's cheap money policy, the housing crisis isn't solving itself.

Bernanke doesn't walk on water. He was far too slow to embrace drastic reform of America's banking system. Still, it is quite a moment in America's economic debate when one of the most progressive figures on monetary and fiscal policy is the Chairman of the Federal Reserve.